Mythbusting economies of scale

Dr. Elliot Parker, an economist at the University of Nevada, Reno, has written a memo (in addition to two newspaper columns) to Nevada System of Higher Education Chancellor Jim Rogers on Nevada's budget, giving reasons why Nevada needs to raise taxes. NPRI has been researching the validity of his claims, and we have already made several counterpoints.

One of Dr. Parker's central claims revolves around the size of Nevada's bureaucracy, which he believes is unusually small, possibly due to under-funding. He claims that Nevada ranks 50th among the states in terms of number of state employees as a percentage of total population, basing his calculations on data from the Statistical Abstract of the United States, Table 451.

Dr. Parker believes that "economies of scale" suggest that small states like Nevada should have larger bureaucracies as a percentage of their population, while large states, like California, should have small bureaucracies as a percentage of their population. Economies of scale would indeed suggest this, if state governments worked under the same sort of incentives that private enterprises do. However, this is an assumption of magnificent proportions – governments have little incentive to operate efficiently, meaning they are unlikely to be able to take advantage of economies of scale.

Doing some of our own research on this issue, this is what we found:

Nevada's number of state and local government employees as a percentage of state population ranks 50th as Dr. Parker states.

The number of local government workers as a percentage of state population ranks 46th.

The number of state government workers as a percentage of state population ranks 49th.

The total size of Nevada government ranks 37th.

The size of Nevada's state government ranks 39th.

The total size of Nevada's local governments ranks 36th.

Nevada's total population in 2005 ranked 35th, meaning it is far from being the smallest state in the union.

If governments were subjected to the same market pressures that keep private enterprise efficient and productive (a very big assumption) then Nevada's bureaucracy may actually be undersized. Then again, it could simply be that government workers in Nevada are highly paid (we rank 16th in state employee pay and 6th in local government employee pay). Or it could be the case that Nevada's employees are more efficient and competent than those of other states – both of which would indicate that Nevada has no need to hire more employees.

But what is interesting is the company Nevada keeps on each list.

When looking at "state government employees as a percentage of population," Nevada is surrounded by some fairly large states (populations are in the thousands).

State

State Gov %

Rank

Population

Rank

Massachusetts

1.11%

40

6,433

13

Pennsylvania

1.11%

41

12,405

6

Texas

1.07%

42

22,928

2

Ohio

1.07%

43

11,470

7

Wisconsin

1.06%

44

5,527

20

New York

0.97%

45

19,315

3

Arizona

0.97%

46

5,953

17

Illinois

0.92%

47

12,765

5

California

0.91%

48

36,154

1

Nevada

0.90%

49

2,412

35

Florida

0.82%

50

17,768

4

On its face, this suggests that more populous states will have smaller state bureaucracies as a percentage of their population. Nevada appears, for whatever reason, to be an anomaly.

But looking at local governments yields something different:

State

Local Gov %

Rank

Population

Rank

Arizona

3.07%

40

5,953

17

Maryland

2.96%

41

5,590

19

Oregon

2.94%

42

3,639

27

West Virginia

2.92%

43

1,814

37

Pennsylvania

2.87%

44

12,405

6

Utah

2.69%

45

2,490

34

Nevada

2.66%

46

2,412

35

Washington

2.64%

47

6,292

14

Rhode Island

2.56%

48

1,074

43

Deleware

2.39%

49

842

45

Hawaii

0.82%

50

1,273

42

Interestingly, less populated states tend to have smaller local governments as a percentage of their populations.

This might suggest that larger states provide more services at the local level or that small states have more efficient local governments than larger states. This might also suggest that Nevada's low ranking for total state employees as a percentage of the state population actually means Nevada's government is more efficient than those of most other states – which would be a good thing.

Finally, a simple regression analysis of each category – state and local employment, local employment, and state employment as a percentage of the population – yields some interesting results. The relationship between a state's population and its total number of employees is, not surprisingly, significant and strongly correlated. But looking at the number of government employees as a percentage of the population, a state's population size has a weak relationship with state employment numbers and has no statistical relationship with local government employment numbers.

In fact, a simple regression analysis suggests that the "economy of scale" that does exist at the state employment level is so infinitesimally tiny that it would require adding 2.5 billion new Nevada residents to reduce "state government workers as a percentage of total population" by one percentage point. In other words, there really is no economy of scale at all.

One can conclude that economies of scale have a very weak impact on a state's ability to reduce employment size and thus do not constitute a strong explanation for why Nevada's bureaucracy is relatively small. More likely explanations include 1) Nevada's government workers are fairly well paid relative to other states' and/or 2) Nevada's government workers may well – because of fewer managers, perhaps – function more competently and efficiently than do other states' workers.

It is doubtful, of course, that Nevada's state and local governments are operating as efficiently and as productively as possible. Since most states have no real merit pay, contract bidding for state services, or fee for services, there is little incentive for governments to be efficient. State tax collection also has no relationship to the need for state services, meaning that states have little incentive to provide high-quality services given they can collect revenue whether or not they provides any services to speak of.